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Do Improving Profits and Low Churn Mean All Is Well at AT&T?

Ahead of AT&T’s (NYSE:T) fourth-quarter earnings report, investors were well aware of the wireless carrier’s problems: its loss of market share to rival Verizon (NYSE:VZ) in the post-paid mobile phone space as the larger company harnesses its expanding LTE coverage to its marketing advantage, as well as growing pressure from T-Mobile’s (NYSE:TMUS) “uncarrier” campaign, which eliminated the annual contracts and fees normally associated with mobile carriers.

Still, while eyes will be watching closely for evidence of AT&T’s profitability in the number of post-paid subscriber additions and the strength of its wireless margins, Wall Street was optimistic about the company’s results. AT&T swung to a profit in the fourth quarter of 2013, although a closer inspection of the numbers show that the company is feeling the competitive heat from T-Mobile.

AT&T beat Wall Street’s top- and bottom-line expectations. The telecommunications company earned a profit of $6.9 billion, or $1.31 per share, which represented significant growth from its year-ago loss of $39 billion, or 68 cents per share. Alongside that turnaround in earnings, revenue rose 1.8 percent to $33.2 billion. Analysts had estimated AT&T would earn 50 cents per share on sales of $33.1 billion, according to Reuters.

But while AT&T beat expectations, analysts and investors were disappointed by its wireless growth. In the three-month period, the second largest wireless provider added just 809,000 net subscribers, below the 1.25 million expected by the Street. That figure includes 566,000 wireless customers on a contract and 440,000 net new tablet customers, as well as new customers to its prepaid and reseller business, which both recorded losses.

AT&T noted in its earnings press release that smartphone gains amounted to 1.2 million new postpaid smartphones added, a figure that referred to both upgrades and new subscribers. For the company, this manner of reporting is new, suggesting that AT&T wished to make results look stronger than they were by using a different metric.

Wireless revenue for AT&T grew 4.8 percent to $18.4 billion, and the company framed last year as a growth year.

“2013 was the year of the network,” AT&T Chairman and CEO Randall Stephenson said in the earnings press release. “With Project VIP, we’re delivering faster speeds and new services to millions more customers,” he added, referring to the company’s initiative to upgrade much of its wireline network to an IP-based infrastructure. “And growth on these platforms is going strong.”

By threatening to draw away customers, T-Mobile has forced AT&T to rethink its offerings. Earlier in January, AT&T announced it would pay customers $200 to switch over, plus provide a credit of up to $250 for trade-in phones. But the company’s rival met that challenge by announcing it would pay up to $350 worth of early termination fees for AT&T subscribers willing to change to its service and credit those customers up to $300 for their old smartphones.

T-Mobile CEO John Legere told CNBC in a January that the switchover incentive was “a desperate move by AT&T on the heels of what must have been a terrible Q4 and holiday for them.” But he believes “consumers won’t be fooled. … Nothing has changed — customers will still feel the same old pain that AT&T is famous for.” During a January news conference, Legere also said he was certain that many AT&T customers were switching to T-Mobile.

Such customer incentive programs, plus the company’s need to subsidize the high cost of Apple’s (NASDAQ:AAPL) latest iPhones, could have an impact of AT&T’s wireless margins and therefore the company’s overall profits. However, operating income margin rose 36.9 percent from the 18.3 percent recorded in the fourth quarter of 2012, while the company’s 2014 guidance maintained that the company “expects stable consolidated margins with continued improvement in wireless margins helping offset Project VIP pressure in wireline.”

As for AT&T’s wireline business, the 630,000 U-Verse Internet customers and the 194,000 U-Verse TV customers the company added in the fourth quarter pushed total subscribers to 10.7 million. With these strong numbers, wireline consumer revenue grew 2.9 percent, year over year, and total U-verse revenue rose 27.9 percent from the year-ago quarter to $13 billion.

Investors, who advanced shares of AT&T a modest 5.67 percent in 2013, reacted negatively to the earnings, pushing the stock down as much as 1.69 percent to $33.13 in after-hours trading.